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Why negative gearing can be a double-edged sword

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When it comes to property investing, one of the most common strategies in Australia is to negatively gear your portfolio. But while it can provide helpful financial support to some investors, it may encourage others to make unwise buying decisions.

What’s negative gearing?

In a nutshell, negative gearing is when the rental income from your property doesn’t cover your expenses such as your mortgage, insurance and management fees. Instead, you make your money by waiting for the property to grow in value and your rental income to steadily increase.

According to the ATO, of the 2,156,319 Australians that owned investment property in 2017, just over 1.3 million had a negatively geared portfolio.

And one of the main reasons why it’s so popular is because it comes with a generous tax break attached. The Australian government lets you offset your real estate expenses against your income reducing the amount of tax you have to pay if you run at a loss.

As an example, imagine you had an investment property that costs you $10,000 per year. At the same time, you earn a $100,000 salary in your day job. As a direct result of the tax concession, you’ll get assessed on an income of $90,000, not $100,000. (Please consult an accountant for expert financial advice.)

But is it the right strategy?

While negative gearing is a popular strategy, that doesn’t necessarily mean it’s the right one for everyone. The aim of buying an investment property should be to make money, not lose money.

Owning an investment property can result in significant capital growth over the long term, but this does depend on you buying a quality property in the first place. Buy the wrong property in the wrong location and its value may not go up enough to offset all your out-of-pocket expenses.

While you wait for the property to grow in value, you’ll keep on incurring monthly losses that can negatively impact your cashflow. A loss is still a loss even if you are saving on your tax bill to compensate.

Meanwhile, should your financial circumstances change for any reason, you’ll still have to keep paying money towards the property or you’ll risk losing it.

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